Renewable Energy REITs or MLPs Would Unlock Billions

Jennifer RunyonAccording to Richard Kauffman, Senior Advisor to the
Secretary, DOE, making REITs or MLPs available for renewable
energy project financing is the key to advancing the industry.

Top engineering,
procurement and construction firms gathered to network, learn and
do business with corporate-level project developers at the PGI
Financial Forum, one of four co-located events that took place in
Orlando, Fla. earlier this month. Richard Kauffman, Senior Advisor
to the Secretary of the U.S. Department of Energy, gave the
keynote address during a luncheon that took place during the
conference.

During the luncheon, Kauffman explained to the 100 attendees
that as someone who originated from the private sector, in his
DOE role he is trying to understand where market forces can be
harnessed in order to unleash the flood of investment that is
needed to bring about large renewable energy projects.

Kauffman explained what he sees as a disconnect between
returns in renewable energy projects compared to returns in
other investments. On the one hand, today, renewable
energy projects are financed in what he called an
“old-fashioned, archaic way” where for the most part, projects
rely on private sector money that is looking for high rates of
returns, typically around 12-14 percent. On the other
hand, money managers, wary of the stock market and its risks,
have returned to the bond markets, which offer more steady
(but lower) rates of return, in the 5 or 6 percent range.
Kauffman explained that this “wall of money” that is looking
for a stable rate of return, such as what can be found in the
bond markets, could easily invest in renewable energy projects
if only the financial vehicle existed that allowed it
to. Renewable energy projects with signed power purchase
agreements (PPAs) will deliver a healthy rate of return to
their investors, one that will be stable for 20 years, exactly
what the money managers are looking for.

In other words, he said, there is all this money looking to
invest in yield but it can’t flow to where it is needed
because the financial vehicles don’t yet exist that would
allow it to.

According to Kauffman, REITs and MLPs, function like a bond
and are currently used in more mature markets for project
development. If they were available to renewable energy
projects, said Kauffman, they would unlock loads of money for
project development. Two separate bills have already
been introduced in Congress seeking to allow renewable energy
projects to be financed through REITs and MLPs but neither
bill has come up for vote yet.

Kauffman asked Financial Forum attendees to imagine for
a minute what would happen if MLPs or REITs could be used to
finance renewable energy projects. He asked attendees to
imagine that they would have a yield of 5 or 6 percent and
simply through that yield, the cost of capital would go down
by 50 percent (since private sector funding demands returns in
the 12 to 14 percent range.)

“But I think it would do five other things,” he explained.

First, Kauffman said that renewable energy REITs or MLPs
would accelerate standardization in the contracting
process. With so many projects now eligible for project
finance, the markets would demand a streamlined contracting
process. This would remove more of the soft costs from
project development.

Second, these renewable energy financial vehicles would
continue to force down solar and other supply chain costs.
Kauffman explained that we are good at logistics in the U.S.
and if we were funding solar projects at increasing rates, we
would improve the logistics in the supply chain. He
pointed to the decreasing costs of residential solar customer
origination through the explosion in solar leasing as an
example of taking costs out of the supply chain.

Third, Kauffman said all of this would then lead to greater
market aggregation of smaller projects. Large projects backed
by stable project developers already have no trouble finding
money to fund their projects. Smaller projects, however,
have a much more difficult time finding cash. If there
were REITs or MLPs available to renewable energy projects,
smaller projects could be aggregated. This would again
improve efficiency and unleash funding for smaller projects.

Fourth, Kauffman believes that REITs or MLPs would encourage
innovation in the industry. He said that capital markets
are much better than banks at assessing risk. If a bank
provides debt to a large innovative project and that project
is unsuccessful, it’s difficult for the bank to recover from
that loss. However, imagine a $100 million fund that
holds a portfolio of projects. If one project defaults, the
fund would still be able to recover because it would hold many
other projects as well. “That’s why the capital markets do a
better job at assessing risk,” said Kauffman.

Finally, if REITs or MLPs were available to renewable energy
projects, the industry would scale very fast, which would
again drive down costs and even open up the possibility of a
forward market. Kauffman said that renewable energy is the
only energy source that gets cheaper the more you make.
So, more projects coming online would help to align the supply
chain and create a forward market.

Since renewable energy is all about the upfront costs,
Kauffman believes that there hasn’t been enough thought put
into how to reduce the cost of capital to finance
projects. REITs or MLPs could play a huge role in the
future because the way renewable energy projects are being
financed today just doesn’t make sense, said Kauffman.

Jennifer Runyon is managing editor of RenewableEnergyWorld.com
and Renewable Energy World North America magazine. She also serves
as conference chair of Solar Power-Gen Conference and Exhibition
and Renewable Energy World North America Conference and Expo.